Southwest Airlines to outline strategy to fix its profitability problem

By Rajesh Kumar Singh

CHICAGO (Reuters) – Southwest Airlines (NYSE:) will lay out a strategy on Thursday to turn around its business and restore profit margins to pre-pandemic levels as the U.S. carrier faces pressure from an activist investor to shake up its management.

The pioneering low-cost airline once boasted a record 47 consecutive years of profit before the COVID-19 pandemic. But aircraft delivery delays by planemaker Boeing (NYSE:)’s, excess capacity in the domestic airline industry and post-pandemic travel patterns have all combined to depress earnings.

Its passenger volumes are running below pre-pandemic levels and shares have lost about 40% of their value in the past three years. It has downgraded its outlook at least eight times in the past 20 months despite booming travel demand and analysts expect profit in 2024 to plunge about 83% from a year ago.

As investors and analysts gather in Dallas on Thursday for Southwest’s first public investor meeting since 2022, they want a credible strategy and timeline to restore its long-term profitability.

The stakes are high. Activist investor Elliott Investment Management has launched a campaign to oust CEO Bob Jordan and replace two-thirds of Southwest’s board of directors, blaming them for the airline’s underperformance. Elliott plans to request a special shareholder meeting as soon as next week to force the changes.

While Southwest has offered the hedge fund some concessions, it has repeatedly backed Jordan, calling him the “right leader” to execute a “significant transformation” of its business and improve financial results.

The company now has to deliver on that promise.

“It could be perilous for them if they don’t execute well,” said Brian Mulberry, client portfolio manager at Zacks Investment Management.

Southwest has already shared preliminary details of its overhaul – switch to assigned and extra-legroom seats to attract premium travelers, and start overnight flights.

It has yet to quantify the revenue boost from these measures. Analysts and investors are also looking for a more precise timeline of the rollout of extra-leg room seats since the new cabin layout requires approvals from the U.S. Federal Aviation Administration (FAA).

The airline is hard pressed for new high-margin revenue streams as its costs have ballooned and are hurting profits. Its operating margin declined to 0.2% in the first half of this year from more than 13% in 2019.

Ahead of Thursday’s meeting, the company told staff that the airline needed to change its network to account for shifts in business travel patterns after the pandemic.

On Wednesday, it slashed its flights to and from Atlanta and asked hundreds of its workers to relocate.

Analysts say Southwest needs to cut more flights across its network as an excess supply of seats in the domestic market dampens airfares.

An industry-wide overcapacity has taken a toll on the earnings of all U.S. airlines, but those with more diversified revenue streams such as Alaska Air (NYSE:) , Delta Air Lines (NYSE:) and United Airlines have performed better.

BOEING PROBLEM

But more importantly, analysts and investors say, the airline needs a solution to Boeing’s aircraft delivery delays.

Southwest operates an all-Boeing fleet. It expects to receive just 20 planes this year, less than one-fourth of its original plans due to the planemaker’s safety crisis.

The delays have left it overstaffed and forced it to defer the retirement of older and less-fuel efficient jets, driving up its operating costs.

Moreover, delays in the FAA certification of Boeing’s MAX 7 aircraft – the smallest version of MAX planes – have compelled it to operate MAX 8 planes, which have more seats and are too big for some of Southwest’s markets.

Flying bigger planes also means more staffing. Analysts at Raymond James estimate Southwest’s full-time employees per aircraft increased to 92 last year from 78 in 2018.

“They’ve been dealt a particularly bad set of cards,” said Robert Mann, a former airline executive who now runs a consulting firm. “They’re really kind of in a rock and a hard place.”